The Siren Song of Public-to-Private (PTP) Buyouts

A BC Partners consortium announced an $8.7B PTP buyout of PetSmart out bidding Apollo and KKR. The deal is the largest buyout of 2014 and one of the rare PTP transactions since the Great Recession. The purchase price is 9.1X railing EBITDA and represents a 40% premium to the pre bidding price. Its capitalization includes 20% equity and 7.2X trailing EBITDA in debt facilities underwritten by Citi, Jefferies, Nomura, Barclays, and Deutsche. The aggressive capitalization runs afoul of U.S. regulatory guidance. Perhaps that is why the bank group includes 2 non banks, Nomura and Jefferies, and 2 foreign banks, Barclays and Deutsche. PetSmart had been under activist pressure to improve its lagging stock price, which had only increased by 3% in the past year. The activist identified pricing, ecommerce and cost issues as factors underlying PetSmart’s performance problems.

More interesting than the deal is the possible return of higher risk-lower quality PTP transactions. PTP deals involve a PE firm taking a public firm private. The grand daddy of PTP was the disastrous RJR deal lead by KKR in the 1980s. PTP transactions are the poster boys of boom period deals. They reached almost 50% of the dollar amount of all LBOs before the financial crisis. The performance of PTP deals like TXU and Caesars, among others, caused PE firms and their investors to swear off PTP. Through 3Q14 the volume of PTP fell to less than 15% of LBOs-the lowest level in a decade. 

The issues with PTP include the following:

1)   Size: they involve large companies which entailed significant capital commitments.

2)   Fully Priced: public firms usually involve auctions which increases the risk of the winner’s curse. While PetSmart’s PPX seemed modest in the current market with PPX exceeding 10X-it still is over 15% higher than the median retail PPX over the past 5 years.

3)   Aggressive Financed: needed to offset the rich price.

4)   Limited Improvement Potential: most public firms have picked the low hanging fruit. Thus, the ability to achieve improvements needed to offset a 40% premium plus achieve a 20% IRR is questionable.

So why might PTP deals like PetSmart be returning? The answer is PE needs to deploy its substantial dry powder. LBO volume remains depressed at 2009 levels. A rising stock market and strategic buyers have simply out priced PE firms. Many recent LBOs have been Sponsor-to-Sponsor (STS) or pass the parcel deals. These involve one PE firm buying another PE firm’s portfolio company. Trouble is STS deals tend to smaller in size, and most the upside has been squeezed out by the original LBO buyer. As boilerplate PE documents highlights-GP carried interest depends on performance which means GP’s are motivated to approve more speculative investments than would ordinarily be the case. Yes, GPs are pirates, but at least they are honest pirates and state upfront what they are going to do to LPs.

PE restraint lasts only so long. When pressured by the need to invest GPs can no longer resist. PTP deals represent another sign, along with high leverage, that the LBO market is entering into a more speculative state. 

j

MergerProf will not publish this Thursday due to the Holiday.  Best wishes of the season to all our readers.